In the world of Sales and Operations Planning (or S&OP), I have seen a disturbing trend over the years among those that control the “purse strings” of these corporations…those formidable folks who generate, control, and police that which is supposed to keep us on the path to glory…the financial budget. Now I’m not going to malign the importance of a budget; it is a very useful tool to help keep everyone aligned towards the organization’s goals, but the budget needs to respect and understand the supply chain. A question that I like to put to clients who are experiencing this issue is, “How is your need to get X% more revenue this year causing your customers to buy X% more of your product?”
Many companies just go on about their daily lives comparing the incoming sales data against their outdated financial budget as though they were handed down on stone tablets.
The problem comes in when the incoming sales (and thus, the revenue) starts to slip against the financial budget. In order to compare the planned/actual revenue against the budget, a few pieces of information are required:
- Year to Date Actual Sales Quantities
- Prices at which the Actual Sales Quantities were sold
- Forecasted Sales Quantities
- Forecasted Sales Prices
Keep in mind that the typical level in the organization of those who generate and monitor this financial budget is much higher than those in the organization who generate and monitor the supply chain forecast. It is at this point that things tend to go off the rails a bit…the person responsible for the budget walks over to the person responsible for the supply chain forecast and instructs him to increase the forecast to cover the budget shortfall. The supply chain forecast typically says, “Yes, Sir!” and increases the forecast. Problem solved. What could go wrong?
Now we obviously can’t influence the quantities and/or prices for those sales that have already occurred, and we typically won’t attempt to change future pricing on products as the impact of that is more difficult to predict. That leaves the forecasted sales quantities as the default place in which to influence the gap between the budget numbers and the actual numbers. Once the gap is realized, it would seem that the easiest way to close that gap is to have the sales forecast be increased. So how do we close this gap? The knee jerk reaction (and from my experience, the most often used) is for the financial executive to go talk to the forecaster to have them bump the forecast upwards so that the world comes back in line. Now in most companies the financial executive is significantly higher up in the organization structure than your typical demand planner and so there is typically little if any resistance to the change even if it skews the forecast accuracy (which it will).
If the forecast goes up, we must be selling more product, right? Not even close…not only does increasing the forecast have catastrophic downstream results increased inventory levels, increased inventory carrying costs, and potentially increased capital expenditures in the form of additional warehouse space. So, in essence, while the financial executive meant well, the effect of his/her decision caused the opposite result and cost the company even more money than it would have by simply leaving the budget gap…and still did nothing to influence the sales of the product.
So how do we fix this? Well, we need to go back to the journey that needs to happen between our current revenue and our target revenue. As with most things in the supply chain world, we need a plan…specifically a more detailed plan as to exactly how we are going to sell more product so that our revenue increases enough to close the gap. Some of the options that can be exercised at this point include:
- Additional promotions (including price promotions, additional advertising, etc.)
- Price increases (if it is determined that the sales will not suffer)
- Price decreases (if it is determined that the volume increase will make up for the lost revenue)
- Additional customers
- Additional markets
Once the impact of the measures above can be estimated, the organization can start to get a better picture of how much sales will increase, how that sales increase will affect their revenue, and how much they need to increase their supply chain forecast to accommodate the new plan.